Stumped - the death of MIS

Another company collapse has raised more questions about managed investment schemes, write Ruth Williams and Philip Hopkins.

23 May 2009 — 12:00am

THIS week, the phrase "Ponzi scheme" was attached to the collapsed managed investment spruiker Great Southern. It was merely the latest, but clearly the worst, label that had been attached to the company in its 20-year history.

In its time, Great Southern was accused of destroying rural communities, of driving up the cost of prime agricultural land, of flogging tax write-offs and spruiking dud investments.

But, along with its peers in the plantation forestry business, it was also praised - by a one-time federal forestry minister, no less - as "vital" to a plan to treble Australia's timber plantations, of having a "legitimate and important role to play" in Australia's timber industry, of yielding significant economic, environmental and social benefits.

By the time the company collapsed a week ago, 47,000 investors had ploughed into tax-effective managed investment scheme (MIS) products - derived from timber and horticultural plantations - 300 accountants and financial planners had signed on to sell the products, 240,000 hectares of trees have been planted and hundreds of farmers had sold their land to Great Southern.

When Great Southern entered administration last Sunday, it was following the fate suffered just weeks before by its agribusiness rival, Timbercorp. Great Southern has an estimated $600 million in debts; its main bankers, ANZ, the Commonwealth, BankWest and the Japanese bank Mizuho, are owed $376 million. They called in receivers on Tuesday.

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As with any corporate collapse, the search has begun for someone to blame. This week, the salaries and perks paid to the company's executives came under fire - interest-free loans of $1.5 million given to the chief executive, Cameron Rhodes, and deputy Phillip Butlin to buy shares in the company and a $1.8 million retirement package to the former executive chairman, John Young.

The accounting profession was forced to do some soul-searching, after it became apparent that most of Great Southern's tax-effective products were sold by accountants for generous commissions.

In the face of another corporate collapse involving thousands of retail investors - following the likes of Westpoint and Storm Financial - the Government has been cautious in its response. This week the Corporate Law Minister, Nick Sherry, said the role of accountants in the MIS schemes "had not passed unnoticed", while adding that the Australian Securities and Investments Commission had an "investigative job to do" in the wake of the collapses.

Meanwhile, the parliamentary joint committee on corporations and financial services is set to launch a special inquiry into MIS. And litigation is pending. Law firm Slater & Gordon is among those looking at class actions or other suits. James Higgins, of Slater & Gordon, said this week that the firm was looking at a range of possible actions, with the role of accountants and financial planners the focus.

It is an ignominious fate for a company that once boasted a share price of $5 and a market capitalisation of more than $700 million, that was one of the top-performing stocks on the ASX 200 during the early 2000s. Its shares are now frozen at 12c; its market cap at $77 million.

Great Southern's expansion capitalised on the Howard government's Plantation 2020 policy, released in 1997, which aimed to treble the amount of plantations by 2020.

Great Southern derived its name from Western Australia's Great Southern region - a fertile slab of sheep, grain and cattle farms and vineyards

containing no-nonsense farming towns and tourist-friendly hubs like Albany and Denmark. It was here that Great Southern's first bluegums were planted in 1994 and where, when the company listed in 1999, the majority of its plantations were located.

Virtually all of the Great Southern region falls within the federal electorate of O'Connor - a seat held by the maverick Liberal MP Wilson Tuckey since 1980.

Tuckey, as minister for forestry for three years from 1998, was a prominent advocate of the industry and of Plantation 2020 - to the point that a letter from him refuting a MIS-negative newspaper article was reprinted in national advertisements paid for by the industry, and in Great Southern's debut annual report of 2000.

The letter underscored the Government's commitment to forestry tax breaks - a 100 per cent deduction for investors in the year they bought the products.

This was important because although Great Southern grew trees, that wasn't how it made most of its money. Its main business was agribusiness-based, tax-effective managed investment schemes - a business that was about to boom on the back of favourable tax treatment.

Mr Tuckey told that Plantation 2020 was designed to ease the pressure on native forests. "Everyone thought it was a good idea at the time," he said.

He said some investors may have been unwise to invest in MIS purely for tax purposes, but investors in woodlots should eventually get their money. "Shareholders and lenders could be in a bit of trouble."

From 2003 to 2008 Great Southern raised $1.8 billion from investors, almost two-thirds of which were in sales of pulpwood forestry MIS - bluegums.

Each year, it packaged and released new MIS schemes - initially in forestry, but expanding to olives, vineyards, cattle and more. Its MIS sales grew from $56 million in 1999 to $314 million last year.

What exactly was it selling? Great Southern's prospectus for its 2002 and 2003 bluegum MIS schemes showed investors paid $3300 to Great Southern, or $3000 before GST, to lease one or more woodlots of one-third of a hectare. If ready money was a problem for the potential "grower", Great Southern could arrange finance (with loans that would later be securitised and sold).

Great Southern selected, bought and prepared the land, planted the trees, monitored them and harvested them in "approximately" 10 years. In return, the grower got a handy tax deduction of $2900 in the year they bought the investment.

The tax write-off was the main inducement but there was also the promise of a return when the trees were harvested in about 10 years - at which point Great Southern would take a portion of the yield in management fees.

How much of a return was coming?

The prospectus makes clear that Great Southern could not make a "definitive" statement on the size of the returns that growers could expect. But it was happy to give a "reasonable" estimate.

Based on assumptions on production costs, woodchip prices and time taken for the trees to mature, Great Southern forecast net returns of between $1923 and $4569 per woodlot for its 2002 project - after investors' initial outlay of $3000 was recouped.

The company was banking on yields of 250 tonnes per hectare. The trees planted for the 2002 scheme are not yet mature, so investors will not receive their returns for some years. What is certain is that their returns will not be subsidised by company money, as earlier distributions were.

Great Southern Plantations (GSP) 1996 was one of the company's earliest projects. Company documents show 783 investors in GSP 1996 paid $3000 for the almost 4000 woodlots they collectively owned. After the investors paid their upfront fees, GSP 1996 sat dormant for a decade.

The trees were growing, the investors had taken their tax deductions. There was little to be done until the harvest in 2007, at which time Great Southern would again earn money from the project and investors could anticipate a return on that decade-old outlay.

Last year, -12 years after the scheme was launched, the project generated $16 million for investors, meaning each woodlot returned about $4100. This gave investors a net return of at least $1100 per woodlot after recouping the $3000 invested in 1996.

But what was not immediately apparent was that a Great Southern subsidiary, Great Southern Export (GSEC), bought all of the timber from the 1996 project - and stumped up almost $10 million of the company's money to inflate the returns to investors.

In its 2007 half-year accounts for the scheme, the company explains that GSEC would set its price after taking into account factors like the "actual yields" and the "prevailing woodchip price".

While no "final decision" had been made by the Great Southern board, it was expected that GSEC would pay investors a premium "over and above the return they would otherwise have achieved" (despite being under no legal obligation to do so, the company reminded investors).

The premium would be "up to" $9.6 million - and was about this, based on later accounts. This means that, of the $16 million returned to investors, as little as $6 million to $7 million could have been recouped from the sale of timber.

If investors had only this money to share between them, they would have taken home between $1500 and $1750 per woodlot - nowhere near their original outlay.

This document starkly illustrates two problems with Great Southern. Firstly, the lengthy gap in earnings from the sale of the MIS products to the harvest, forcing the company to survive in the meantime on sales of new MIS products.

The other problem was yields - they were much lower than expected. Although the woodchip price was holding up, the plantations weren't producing enough timber to make the projects viable.

A Tasmanian accountant, John Lawrence, who lives near Burnie, has long kept an eye on the MIS industry since the MIS forestry companies came searching for properties in his region and his clients wanted advice.

Lawrence claims Great Southern's yields were kept hidden for a long time. "The first crop was 1994, which they would have harvested in 2005," he says. "The yield there was about 123 tonnes per hectare, whereas they were projecting 250 tonnes and the next year was similarly bad, about 160 tonnes."

Mr Lawrence, and others, noticed a telling change in Great Southern's accounting practices in the months before it folded.

Great Southern's accounting policy was not to recognise the plantation management and property rental fees it would reap at harvest - "until the value of the project's net harvest proceeds can be measured reliably," as it stated in its 2007 accounts. But four months later, a supplementary explanatory document lodged by the company showed a significant change in policy - a change repeated in its annual accounts.

Great Southern had now decided to "update" its valuation model on the basis that "reliable measurement" of the proceeds of a plantation harvest could be made after four years of timber growth. This meant it was recognising $17 million in fees for management services performed on trees planted from 1998 to 2003 in its current accounts - despite the fact that it would not physically get this money until the trees were harvested in as many as three or four years.

Mr Lawrence argues that this proves the company knew it had been overstating projected yields for years.

"That was such a damning admission," he says. "It means that Great Southern have known all along how poor the yields have been because they can assess them at four years - and they never ever told the market."

It was Great Southern's continued reliance on drawing in money from new investors, coupled with its practice of beefing up investor returns, that has sparked the "Ponzi" accusations. A classic Ponzi scheme involves investors being paid "returns" out of funds drawn in from new investors. It relies on new money constantly coming in.

Mr Lawrence, for one, is convinced that Great Southern was a Ponzi scheme. On his advice, the Greens senator, Christine Milne, wrote to ASIC late last year.

Senator Milne's letter to ASIC points to what appears to be a pattern of misrepresentations, deceptive behaviour and misreporting, on the basis that its product disclosure statements consistently overstated the yields investors could expect.

ASIC's letter in response said there was "insufficient evidence" to conclude that Great Southern was a Ponzi scheme.

"A general indicator of such a scheme is a lack of assets," ASIC said, pointing to Great Southern's reported net assets of $329 million at September 30, and its audited accounts.

Although ASIC noted that yields had fallen short of projected outcomes, it was not "necessarily" misleading or deceptive if the company has disclosed potential risks to investors, the corporate regulator said.

Based on Senator Sherry's comments this week, ASIC is investigating aspects of the Great Southern and Timbercorp collapses.

ASIC declined to comment yesterday.

But if the fundamental purpose of the company - to grow trees - was not going so well, there were lots of other problems creeping up on the company.

Its growing debt, for a start. Great Southern's policy was to own the land on which the plantations grew, meaning that if it wanted to launch more MIS products, it had to buy more land. And along the way, it bought or established new businesses - such as rural funds management and cattle stations - in an attempt to diversify away from bluegum-based products.

The acquisitions were funded by equity raisings and bank loans. Its debt facilities were extended in 2007, to $350 million from $245 million, at which point the company admitted it had "fully drawn down on the facility to its limit".

Meanwhile, it was battling high costs - especially the cost of its distribution model. Great Southern spent almost $137 million on commissions, marketing and promotion in two years to 2008. To help convince accountants and planners to sell clients its MIS products, Great Southern paid generous commissions of up to 10 per cent.

To get the accountants registered as "authorised representatives" of Great Southern Securities, the company also had to spend money training them. By 2007, the company could boast of "working relationships" with 1100 "supporters" of Great Southern's products. "Great Southern has developed a very strong relationship with the accounting profession in Australia and works closely with over 300 accountants nationally," the company said.

James Higgins, from the law firm Slater & Gordon, points out that the 10 per cent commissions were "in the same ball park" as those involved with Westpoint or Storm Financial. "It's amazing how often they involve high commissions," he observes.

Slater & Gordon is examining whether clients were "inappropriately" put in the Great Southern and Timbercorp schemes by commission-hungry accountants and financial planners.

Higgins, for one, believes some form of litigation is "inevitable".

The fact that accountants were responsible for distributing Great Southern's products has prompted much soul-searching in the profession. Some believe the "authorised representative" system - where an accountant can be authorised to give financial advice in one product area, like MIS - needs revamping, along with the practice of product makers paying commissions.

Great Southern also spent substantial sums promoting the industry, and defending itself against what was, at times, determined community opposition to the plantations. Great Southern, like Timbercorp and others, sank money into industry lobby groups to press the industry's case in Canberra and elsewhere. It gave donations to political parties - $20,000 each to the Liberal Party, the National Party and Labor in the 2004-05 election year.

When, after a decade of support, the Howard government turned on the industry in 2007 by scaling back tax advantages, Great Southern knew it had a problem. The changes related to non-forestry MIS - a prime area of expansion for both Great Southern and Timbercorp in the years before the change.

Labor came to office later that year, promising to review non-forestry MIS schemes. This gave Great Southern, in the words of the then managing director John Young, in the 2007 annual report, "renewed cause for optimism".

As revealed by this week, Great Southern gave Labor $40,000 in donations before the federal election - including $10,000 on November 22. The timing was significant - two days after Labor's MIS-positive primary industry policy was released, and two days before the 2007 election.

Late last year, the Tax Office's ruling relating to non-forestry MIS was overturned by the Federal Court. For Great Southern, it might have been a cause for celebration, if the damage had not already done. The sudden loss of support from the Howard government had exposed Great Southern's vulnerability to policy changes and Tax Office rulings. Its sales of MIS slumped.

Late last year, the company unveiled a radical restructure, dubbed "Project Transform". It involved selling assets to pay down its debts, reducing costs and, crucially, buying out tens of thousands of MIS investors - giving them Great Southern shares instead of the harvest proceeds. The offer was between 3500 and 6000 Great Southern shares per woodlot - working out at a return of between $700 and $1200, based on the 20c that Great Southern shares were worth by the end of the year.

Investors who bought on the basis of that 2002 and 2003 prospectus - who were tempted with possible returns of up to $4569 per lot - were among those approached to convert their holdings into shares. To help them make their decision, they were given an independent expert's report prepared by KPMG. That report included projected yields for the 2003 scheme, calculated by the forestry assessor GHD.

Back in that 2002 and 2003 prospectus, Great Southern said it could "reasonably expect" its trees to yield 250 tonnes, or cubic metres, per hectare. But the GHD projections show that, although a small number of trees were expected to over-deliver at 311 cubic metres, most were falling far short of expectations with yields of between 107 and 167 cubic metres - drastically short of what was expected. -

Why? The trees were growing in a period of drought, for one thing. And Great Southern had, in the past, acknowledged problems with earlier plantings, such as lower quality seeds and poor choice of sites.

Whatever the reason, the plantation investors overwhelmingly rejected Great Southern's proposal to swap their trees for shares, although a similar offer to beef cattle MIS investors was accepted.

In April, the company released an update. The tone was upbeat, but the content was telling. Great Southern could not borrow any more money. It was slashing costs but "cash flows (remained) dependent on the sale of assets and continued reliance on MIS sales".

Great Southern's shares were frozen on May 7 and the board appointed administrators on May 16. Receivers are now picking over the company.

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Slater & Gordon is not the only law firm fielding calls from angry creditors, investors and shareholders, and litigation funder IMF is also keeping tabs on the situation.

Meanwhile, thousands of hectares of bluegums keep growing, awaiting harvest. Just who will maintain the trees and harvest the timber is unclear.